S Corporation Eligibility Requirements

The 100-Shareholder Limit

Per the IRS, an S corporation cannot have more than 100 shareholders. A married couple, and their estate, count as a single shareholder for this purpose, and the tax code lets members of the same family, generally anyone within six generations of a common ancestor plus spouses and former spouses, elect to be treated as one shareholder too. This family-aggregation rule lets a multi-generational family business stay under the cap even with many individual family members holding stock.

Who Can Be a Shareholder

S corporation shareholders must be individuals, certain trusts (such as grantor trusts, voting trusts, qualified subchapter S trusts, and electing small business trusts), or estates. A partnership, a corporation, or a non-resident alien cannot hold S corporation stock. This rule rules out an S corporation as the vehicle of choice for a business with institutional or foreign corporate investors; a C corporation doesn't have this restriction.

Only One Class of Stock

The corporation can have only one class of stock outstanding. The IRS treats stock as a single class as long as every share carries identical rights to distribution and liquidation proceeds; differences in voting rights among shares, such as voting and non-voting common stock, don't by themselves violate this rule. A corporation that wants to issue true preferred stock with different economic rights generally can't do so and keep its S election.

Must Be a Domestic Corporation

An S corporation has to be a domestic corporation, meaning one organized under U.S. federal or state law. A foreign corporation cannot elect S status, and an eligible entity, like an LLC, that wants S corporation tax treatment has to first elect to be taxed as a corporation (or be treated as one by default) before it can also elect S status.

Certain Corporations Are Ineligible

The IRS excludes a short list of corporation types from S corporation eligibility regardless of shareholder count or stock structure: certain financial institutions that use the reserve method of accounting for bad debts, insurance companies taxed under subchapter L of the tax code, and certain corporations that have, or had, a valid election as a domestic international sales corporation (DISC) or former DISC.

Eligibility Is Continuous, Not Just at Election

Meeting every eligibility rule isn't a one-time check at the time of filing Form 2553. If an S corporation later violates any rule, for example a shareholder transfers stock to a corporation, or the company issues a second class of stock, the S election terminates automatically as of the date of the violation, and the corporation reverts to C corporation tax treatment for the rest of that year and going forward unless it re-elects.

A Single Ineligible Shareholder Can End the Election

Because eligibility is tested continuously, a single stock transfer to an ineligible shareholder, intentional or not, can terminate the S election for the whole corporation. Use a shareholder agreement that restricts transfers to eligible owners, and review any proposed transfer against the eligibility rules before it happens.

Trusts Need the Right Kind of Provisions

Not every trust qualifies as an eligible S corporation shareholder; a trust generally needs specific provisions, as a grantor trust, a qualified subchapter S trust, or an electing small business trust, to hold S corporation stock without disqualifying the election. Have an estate planning attorney review any trust that will hold S corporation stock.

Reinstating a Terminated Election Isn't Automatic

If an S election terminates because of an eligibility violation, getting S status back generally requires a new election and, in some cases, IRS consent if it's within five years of the termination. Fix the underlying eligibility problem and consult a tax professional promptly if a violation happens.

This Isn't Tax Advice

Eligibility rules have specific definitions and exceptions beyond what's summarized here. Talk to a tax professional before electing S status or whenever a change in shareholders, trusts, or stock is being considered.